Chapter 5 Class

Question 1

who publishes an integrated framework of internal controls?

Answer 1

The Committee of Sponsoring Organizations (COSO)

Question 2

COSO’s 3 categories for internal control to provide assurance in:

Answer 2

• reliability of financial reporting
• effectiveness and efficiency of operations
• compliance with laws and regulations

Question 3

how are auditors primarily concerned with a client’s internal control system?

Answer 3

how it relates to the reliability of financial reporting

Question 4

SOX requires ________ to asses and report on the entity’s internal control over financial reporting

Answer 4

management

Question 5

material weakness

Answer 5

a deficiency in internal control such that there is a reasonable possibility that a material misstatement will not be caught

Question 6

what do auditors do only for issuer companies when evaluating internal controls?

Answer 6

issue an opinion on the effectiveness of the entity’s internal control over financial reporting

Question 7

3 responsibilities of auditors when evaluating internal controls for public companies:

Answer 7

1. issue an opinion on the effectiveness of their internal control over financial reporting
2. assess the preliminary risk of material misstatement for each relevant assertion
3. evaluate whether the client has implemented control activities that are specifically designed to address each fraud risk

Question 8

2 responsibilities of auditors on nonissuer companies:

Answer 8

1. assess the preliminary risk of material misstatement for each relevant assertion
2. evaluate whether the client has implemented control activities that are specifically designed to address each fraud risk

Question 9

high assessed control risk indicates:

Answer 9

controls are not effective at preventing or detecting misstatements
- use substantive testing
- large sample sizes
- lower detection risk

Question 10

low assessed control risk indicates:

Answer 10

controls are effective at preventing or detecting material misstatements
- use analytical testing
- smaller sample sizes
- high detection risk

Question 11

low assessed control risk needs ________ testing;
high assessed control risk needs _________ testing

Answer 11

analytical
substantive

Question 12

COSO’s 5 components of a properly designed internal control system:

Answer 12

1. control activities
2. risk assessment
3. information and communication
4. monitoring
5. control environment
   (CRIME)

Question 13

which risks have an inverse relationship?

Answer 13

control risk and detection risk

Question 14

control environment

Answer 14

sets the tone of the organization and is the foundation for all other components
- integrity and values
- organizational structure
- financial reporting competencies

Question 15

risk assessment

Answer 15

the business risks ultimately managed by management, boards, and employees

Question 16

auditors have to gain an understanding of management’s _________ process

Answer 16

risk assessment

Question 17

control activities

Answer 17

specific actions that management and employees take to help ensure management’s directions are carried out

Question 18

what does an auditor determine in relation to control activities?

Answer 18

• what could go wrong
• what control activities management implements in response to what could go wrong

Question 19

preventative controls

Answer 19

prevent misstatements before they occur

Question 20

detective controls

Answer 20

detect misstatements after they occur

Question 21

management review controls

Answer 21

periodic management reviews and follow-up actions to correct identified errors

Question 22

information processing control activities

Answer 22

designed to ensure the completeness and accuracy of system-generated reports

Question 23

physical security controls

Answer 23

physical access to data should be limited to authorized personnel only

Question 24

4 types of separations of duties that should be performed by different persons:

Answer 24

1. authorization to execute transactions
2. recording transactions
3. custody of assets involved in the transaction
4. periodic reconciliation of existing assets

Question 25

5 limitations of internal control

Answer 25

1. human error 2. deliberate circumvention 3. management override 4. collusion 5. cot-benefit considerations

Question 26

3 phases of an auditor's internal control evaluation:

Answer 26

1. understanding 2. assessment 3. testing

Question 27

entity-level controls

Answer 27

controls pervasive to the internal control system - evaluated during the understanding phase

Question 28

transaction-level controls

Answer 28

controls that pertain to specific classes of transactions, balances, and disclosures - evaluated during the understanding phase

Question 29

how must the audit team document their understanding of the internal control system?

Answer 29

- narrative description - flowchart - questionnaire

Question 30

4 essential parts of the narrative description

Answer 30

- the origin of every document and record in the system - all processing that takes place - disposition of every document and record - an indication of the controls relevant to control risk

Question 31

testing of controls is required for ________ companies

Answer 31

public

Question 32

phase 2 of evaluating the internal control system

Answer 32

Assess the Control Risk

Question 33

relevant assertions to the cash account

Answer 33

- existence - valuation

Question 34

phase 3 of evaluating the internal control system

Answer 34

Identify and Perform Tests of Controls

Question 35

if controls are found to be operating effectively, the control risk is assessed _______ the maximum

Answer 35

below

Question 36

control risk lower: detection risk _______ _____ substantive testing

Answer 36

higher less

Question 37

control risk higher: detection risk _______ _____ substantive testing

Answer 37

lower more

Question 38

if controls are not found to be operating effectively, control risk is assessed as ______

Answer 38

high

Question 39

4 methods of testing controls (least to most persuasive):

Answer 39

1. inquiry of personnel 2. observation of the control 3. inspection of documentation 4. reperformance of the control activity

Question 40

unqualified opinion

Answer 40

no material weaknesses exist

Question 41

disclaimer of opinion

Answer 41

the audit team cannot perform all necessary procedures and therefore do not know if material weaknesses exist

Question 42

adverse opinion

Answer 42

one or more material weaknesses exist

Question 43

design deficiency

Answer 43

a problem relating to either a necessary control that is missing or an existing control that is poorly designed

Question 44

operating deficiency

Answer 44

a properly designed control is either ignored or inappropriately applied

Question 45

when auditing a non-issuer, when do auditors have to test internal controls for operating effectiveness?

Answer 45

when they plan to rely on those internal controls